FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended........................ June 30, 2002
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[ X ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from to
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Commission File Number 0-26584
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BANNER CORPORATION
------------------
(Exact name of registrant as specified in its charter)
Washington 91-1691604
- ------------------------------- -------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10 S. First Avenue Walla Walla, Washington 99362
---------------------------------------------------------
(Address of principal executive offices and zip code)
(509) 527-3636
--------------------------
(Registrant's telephone number, including area code)
(Former name, former address and former fiscal year, if changed since last
report.)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
(1) Yes X No
------- -------
APPLICABLE ONLY TO CORPORATE ISSUERS
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Title of class: As of July 31, 2002
--------------- -------------------
Common stock, $.01 par value 11,580,754 shares *
* Includes 577,039 shares held by employee stock ownership plan (ESOP)
that have not been released, committed to be released, or allocated
to participant accounts.
Banner Corporation and Subsidiaries
Table of Contents
PART I - FINANCIAL INFORMATION
ITEM 1 - Financial Statements. The Consolidated Financial Statements of
Banner Corporation and Subsidiaries filed as a part of the report are as
follows:
Consolidated Statements of Financial Condition
as of June 30, 2002 and December 31, 2001.............................. 2
Consolidated Statements of Income
for the Quarters and Six Months Ended June 30, 2002 and 2001........... 3
Consolidated Statements of Comprehensive Income
for the Quarters and Six Months Ended June 30, 2002 and 2001........... 4
Consolidated Statements of Changes in Stockholders' Equity
for the Six Months Ended June 30, 2002 and 2001........................ 5
Consolidated Statements of Cash Flows
for the Quarters and Six Months Ended June 30, 2002 and 2001........... 8
Selected Notes to Consolidated Financial Statements.................... 10
ITEM 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operation
General................................................................ 14
Recent Developments and Significant Events............................. 15
Comparison of Financial Condition at June 30, 2002 and December 31,
2001.................................................................. 15
Comparison of Results of Operations for the Quarters and Six Months
Ended June 30, 2002 and 2001.......................................... 15
Asset Quality......................................................... 21
Liquidity and Capital Resources....................................... 22
Capital Requirements.................................................. 22
ITEM 3 - Quantitative and Qualitative Disclosures About Market Risk
Market Risk and Asset/Liability Management............................ 23
PART II - OTHER INFORMATION
Item 1. Legal Proceedings............................................. 27
Item 2. Changes in Securities......................................... 27
Item 3. Defaults upon Senior Securities............................... 27
Item 4. Submission of Matters to a Vote of Stockholders............... 27
Item 5. Other Information............................................. 27
Item 6. Exhibits and Reports on Form 8-K.............................. 27
SIGNATURES............................................................... 28
CERTIFICATION............................................................ 29
1
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (in thousands, except shares)
(Unaudited)
June 30 December 31
ASSETS 2002 2001
----------- -----------
Cash and due from banks $ 93,276 $ 67,728
Securities available for sale, cost $357,674
and $298,332
Encumbered 61,877 64,126
Unencumbered 299,727 237,721
----------- -----------
361,604 301,847
Securities held to maturity, fair value
$14,625 and $14,902 14,435 14,828
Federal Home Loan Bank stock 31,800 30,840
Loans receivable:
Held for sale, fair value $10,677 and
$43,647 10,491 43,235
Held for portfolio 1,558,176 1,549,742
Allowance for loan losses (16,646) (17,552)
----------- -----------
1,552,021 1,575,425
Accrued interest receivable 13,994 12,929
Real estate owned, held for sale, net 6,253 3,011
Property and equipment, net 18,502 18,151
Costs in excess of net assets acquired
(goodwill and intangibles), net 36,817 31,437
Deferred income tax asset, net 1,910 1,443
Bank owned life insurance 30,895 20,304
Other assets 3,191 9,151
----------- -----------
$ 2,164,698 $ 2,087,094
=========== ===========
LIABILITIES
Deposits:
Non-interest-bearing $ 196,221 $ 180,813
Interest-bearing 1,230,667 1,114,998
----------- -----------
1,426,888 1,295,811
Advances from Federal Home Loan Bank 431,183 501,982
Trust preferred securities 25,000 --
Other borrowings 68,723 76,715
Accrued expenses and other liabilities 12,406 17,591
Deferred compensation 2,960 2,655
Income taxes payable 555 --
----------- -----------
1,967,715 1,894,754
STOCKHOLDERS' EQUITY
Common stock - $0.01 par value, 27,500,000
shares authorized, 13,201,418 shares issued:
11,671,937 shares and 11,634,159 shares
outstanding at June 30, 2002 and December
31, 2001, respectively. 127,250 126,844
Retained earnings 72,054 68,104
Accumulated other comprehensive income:
Unrealized gain (loss) on securities
available for sale 2,534 2,264
Unearned shares of common stock issued to
Employee Stock Ownership Plan (ESOP) trust:
577,039 and 577,039 restricted shares
outstanding at June 30, 2002 and December
31, 2001, respectively, at cost (4,769) (4,769)
Carrying value of shares held in trust for stock
related compensation plans (2,523) (2,870)
Liability for common stock issued to deferred,
stock related, compensation plan 2,437 2,767
----------- -----------
(86) (103)
----------- -----------
196,983 192,340
----------- -----------
$ 2,164,698 $ 2,087,094
=========== ===========
See selected notes to consolidated financial statements
2
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited) (in thousands except for per share amounts)
Quarters Ended Six Months Ended
*Restated (See Note 7) June 30 June 30
-------------------- ------------------
2002 2001* 2002 2001*
-------- -------- -------- --------
INTEREST INCOME:
Loans receivable $ 30,702 $ 34,257 $ 61,953 $ 68,919
Mortgage-backed securities 2,886 3,005 5,442 6,277
Securities and deposits 2,688 2,477 4,899 5,121
-------- -------- -------- --------
36,276 39,739 72,294 80,317
INTEREST EXPENSE:
Deposits 9,874 13,992 20,018 28,211
Federal Home Loan Bank
advances 6,231 7,686 12,699 15,506
Trust preferred securities 338 -- 338 --
Other borrowings 400 867 892 1,935
-------- -------- -------- --------
16,843 22,545 33,947 45,652
-------- -------- -------- --------
Net interest income before
provision for loan losses 19,433 17,194 38,347 34,665
PROVISION FOR LOAN LOSSES 4,000 2,950 7,000 3,900
-------- -------- -------- --------
Net interest income 15,433 14,244 31,347 30,765
OTHER OPERATING INCOME:
Loan servicing fees 413 285 757 595
Other fees and service
charges 1,548 1,468 2,806 2,931
Gain on sale of loans 1,128 1,222 2,419 2,083
Gain (loss) on sale of
securities 12 360 17 360
Miscellaneous 448 300 768 531
-------- -------- -------- --------
Total other operating
income 3,549 3,635 6,767 6,500
OTHER OPERATING EXPENSES:
Salary and employee benefits 9,090 7,625 17,784 15,004
Less capitalized loan
origination costs (1,292) (1,371) (2,605) (2,436)
Occupancy and equipment 2,039 1,885 4,122 3,744
Information/computer data
services 724 859 1,337 1,502
Advertising 298 215 597 418
Check kiting loss -- 2,600 -- 6,200
Amortization of goodwill and
CDI 53 795 128 1,590
Miscellaneous 2,928 2,593 5,803 4,890
-------- -------- -------- --------
Total other operating
expenses 13,840 15,201 27,166 30,912
-------- -------- -------- --------
Income before provision for
income taxes 5,142 2,678 10,948 6,353
PROVISION FOR INCOME TAXES 1,615 1,059 3,512 2,425
-------- -------- -------- --------
NET INCOME $ 3,527 $ 1,619 $ 7,436 $ 3,928
======== ======== ======== ========
Net income per common share,
see Note 5:
Basic $ .32 $ .14 $ .67 $ .35
Diluted $ .30 $ .14 $ .65 $ .34
Cumulative dividends declared
per common share: $ .15 $ .14 $ .30 $ .28
See selected notes to consolidated financial statements
3
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited) (in thousands)
Quarters Ended Six Months Ended
June 30 June 30
------------------- -------------------
*Restated (See Note 7) 2002 2001* 2002 2001*
------- -------- ------- -------
NET INCOME $ 3,527 $ 1,619 $ 7,436 $ 3,928
OTHER COMPREHENSIVE INCOME
(LOSS), NET OF INCOME TAXES:
Unrealized holding gain
(loss) during the period,
net of deferred income tax
(benefit) of $1,297, $102,
$151 and $1,282,
respectively 2,409 199 281 2,317
Less adjustment for (gains)/
losses included in net
income, net of income tax
(benefit) of $4, $126, $6
and $126, respectively (8) (234) (11) (234)
------- ------- ------- -------
Other comprehensive income
(loss) 2,401 (35) 270 2,083
------- ------- ------- -------
COMPREHENSIVE INCOME $ 5,928 $ 1,584 $ 7,706 $ 6,011
======= ======= ======= =======
See selected notes to consolidated financial statements
4
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited) (in thousands)
For the Six Months Ended June 30, 2002 and 2001
Carrying Value,
Net of Liability,
Of Shares Held
Common Stock Accumulated Unearned in Trust for
And Additional Other Restricted Stock-Related Total
Paid-in Retained Comprehensive ESOP Shares Compensation Stockholders'
Restated (See Note 7) Capital Earnings Income at cost Plans Equity
--------- -------- -------- -------- ------ ---------
<c> <c> <c> <c> <c> <c> <c>
BALANCE, January 1, 2001 $ 133,839 $ 66,893 $ (1,125) $ (5,234) $ (578) $ 193,795
Net income 3,928 3,928
Change in valuation of
securities available
for sale, net of income
taxes 2,083 2,083
Cash dividend on common
stock ($.28/share
cumulative) (3,298) (3,298)
Purchase and retirement
of common stock (5,429) (5,429)
Proceeds from issuance
of common stock for
exercise of stock
options 1,384 1,384
Release of treasury stock
for MRP grant 52 (52)
Amortization of
compensation related
to MRP 516 516
Forfeiture or net change
in the number and/or
carrying value of
shares held in trust
for compensation plans (3) 3 --
--------- -------- -------- -------- ------ ---------
BALANCE, June 30, 2001 $ 129,843 $ 67,523 $ 958 $ (5,234) $ (111) $ 192,979
========= ======== ======== ========= ======= ==========
Continued
5
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited) (in thousands)
For the Six Months Ended June 30, 2002 and 2001
Carrying Value,
Net of Liability,
Of Shares Held
Common Stock Accumulated Unearned in Trust for
And Additional Other Restricted Stock-Related Total
Paid-in Retained Comprehensive ESOP Shares Compensation Stockholders'
Restated (See Note 7) Capital Earnings Income at cost Plans Equity
--------- -------- ------- -------- ------ ---------
<s> <c> <c> <c> <c> <c> <c>
BALANCE, January 1, 2002 $ 126,844 $ 68,104 $ 2,264 $ (4,769) $ (103) $ 192,340
Net income 7,436 7,436
Change in valuation of
securities available
for sale, net of income
taxes 270 270
Cash dividend on common
stock ($.30/share
cumulative) (3,486) (3,486)
Purchase and retirement
of common stock (738) (738)
Proceeds from issuance
of common stock for
exercise of stock
options 1,144 1,144
Amortization of
compensation related
to MRP 17 17
--------- -------- ------- -------- ------ ---------
BALANCE, June 30, 2002 $ 127,250 $ 72,054 $ 2,534 $ (4,769) $ (86) $ 196,983
========= ======== ======= ======== ====== =========
See selected notes to consolidated financial statements
6
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
(Unaudited) (continued) (in thousands)
For the Six Months Ended June 30, 2002 and 2001
2002 2001
------ ------
COMMON STOCK, SHARES ISSUED:
Number of shares, beginning of period 13,201 13,201
------ ------
Number of shares, end of period 13,201 13,201
------ ------
LESS COMMON stock PURCHASED AND RETIRED:
Number of shares, beginning of period (1,567) (1,196)
Purchase and retirement of common stock (40) (288)
Issuance of common stock to deferred
compensation plan and/or exercised stock
options 78 123
------ ------
Number of shares repurchased/retired, end
of period (1,529) (1,361)
------ ------
Shares issued and outstanding, end of period 11,672 11,840
====== ======
UNEARNED, RESTRICTED ESOP SHARES:
Number of shares, beginning of period (577) (633)
Release of earned shares -- --
------ ------
Number of shares, end of period (577) (633)
====== ======
See selected notes to consolidated financial statements
7
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (in thousands)
For the Six Months Ended June 30, 2002 and 2001
*Restated (See Note 7)
2002 2001*
--------- ---------
OPERATING ACTIVITIES
Net income $ 7,436 $ 3,928
Adjustments to reconcile net income to
net cash provided by operating
activities:
Depreciation and amortization 1,484 3,335
Loss (gain) on sale of securities (17) (360)
Increase in cash surrender value of bank
owned life insurance (591) (492)
Loss (gain) on sale of loans (1,933) (1,991)
Loss (gain) on disposal of real estate
held for sale and property and equipment 130 (8)
Provision for losses on loans and real
estate held for sale 7,000 3,991
FHLB stock dividend (926) (973)
Change, net of acquisition, in:
Loans held for sale 32,744 (18,205)
Other assets 4,516 (1,274)
Other liabilities (4,565) (216)
--------- ---------
Net cash provided (used) by
operating activities 45,278 (12,265)
--------- ---------
INVESTING ACTIVITIES:
Purchases of securities (140,429) (32,118)
Principal repayments and maturities of
securities 78,025 62,123
Proceeds from sales of securities 4,541 1,372
Origination of loans, net of principal
repayments (140,857) (212,170)
Purchases of loans and participating
interest in loans (3,919) (1,311)
Proceeds from sales of loans and
participating interest in loans 160,413 134,418
Purchases of property and equipment-net (1,618) (1,793)
Proceeds from sale of real estate held
for sale-net 626 2,383
Investment in bank owned life insurance (10,000) (5,000)
Cash (used for) provided by acquisitions (6,519) --
Other (116) (41)
--------- ---------
Net cash used by investing activities (59,853) (52,137)
--------- ---------
FINANCING ACTIVITIES
Increase (decrease) in deposits 97,578 67,288
Proceeds from FHLB advances 156,501 106,464
Repayment of FHLB advances (227,300) (109,480)
Proceeds from issuance of trust preferred
securities 25,000 --
Proceeds from repurchase agreement
borrowings 1,226 --
Repayments of repurchase agreement
borrowings (6,754) (9,628)
Increase (decrease) in other borrowings (3,165) 84
Cash dividends paid (3,369) (3,321)
Repurchases of stock, net of forfeitures (738) (5,429)
Other 1,144 1,384
--------- ---------
Net cash provided by financing
activities 40,123 47,362
--------- ---------
NET INCREASE (DECREASE) IN CASH AND DUE
FROM BANK 25,548 (17,040)
CASH AND DUE FROM BANKS, BEGINNING OF PERIOD 67,728 67,356
--------- ---------
CASH AND DUE FROM BANKS, END OF PERIOD $ 93,276 $ 50,316
========= =========
(Continued on next page)
8
BANNER CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) (in thousands)
For the Six Months Ended June 30, 2002 and 2001
(Continued from prior page)
2002 2001*
--------- ---------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW
INFORMATION:
Interest paid in cash $ 33,958 $ 45,332
Taxes paid in cash $ 2,500 $ 5,607
Non-cash transactions:
Loans, net of discounts, specific loss
allowances and unearned income,
transferred to real estate owned $ 4,004 $ 2,422
Net change in accrued dividends payable $ 117 $ 23
Other assets/liabilities $ 45 $ --
The following summarizes the non-cash
activities relating to acquisitions:
Fair value of assets and intangibles
acquired, including goodwill $ (44,544) $ --
Fair value of liabilities assumed 34,453 --
Fair value of stock issued and options
assumed to acquisitions' shareholders -- -
--------- ---------
Cash paid out in acquisition (10,091) --
Less cash acquired 3,572 -
--------- ---------
Net cash acquired (used) $ (6,519) -
========= =========
See selected notes to consolidated financial statements
9
BANNER CORPORATION AND SUBSIDIARIES
SELECTED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1: Basis of Presentation
Banner Corporation (BANR or the Company) is a bank holding company
incorporated in the State of Washington. The Company is primarily engaged in
the business of planning, directing and coordinating the business activities
of its wholly-owned subsidiary, Banner Bank (BB or the Bank). BB is a
Washington-chartered commercial bank the deposits of which are insured by the
Federal Deposit Insurance Corporation (FDIC) under both the Bank Insurance
Fund (BIF) and the Savings Association Insurance Fund (SAIF). BB conducts
business from its main office in Walla Walla, Washington, and its 41 branch
offices and six loan production offices located in Washington, Oregon and
Idaho, including two new branch offices in Washington state opened in August
2002.
The Company is subject to regulation by the Federal Reserve Board (FRB). The
Bank is subject to regulation by the State of Washington Department of
Financial Institutions' Division of Banks and the FDIC.
In the opinion of management, the accompanying consolidated statements of
financial condition and related interim consolidated statements of income,
comprehensive income, changes in stockholders' equity and cash flows reflect
all adjustments (which include reclassifications and normal recurring
adjustments) that are necessary for a fair presentation in conformity with
generally accepted accounting principles ("GAAP"). The preparation of
financial statements in conformity with GAAP requires management to make
estimates and assumptions that affect amounts reported in the financial
statements. Actual results could differ from these estimates and may have a
material impact on the financial statements.
Various elements of our accounting policies, by their nature, are inherently
subject to estimation techniques, valuation assumptions and other subjective
assessments. In particular, we have identified several accounting policies
that, due to the judgments, estimates and assumptions inherent in those
policies, are critical to an understanding of our financial statements. These
policies relate to the methodology for the determination of our allowance for
loan and lease losses, the valuation of goodwill, and the valuation of real
estate held for sale. These policies and the judgments, estimates and
assumptions are described in greater detail in subsequent sections of
Management's Discussion and Analysis and in Note 1 of the Notes to the
Consolidated Financial Statements which is part of Banner Corporation's 2001
Annual Report on Form 10-K filed with the Securities and Exchange Commission
(SEC). We believe that the judgments, estimates and assumptions used in the
preparation of our financial statements are appropriate given the factual
circumstances at the time. However, given the sensitivity of our financial
statements to these critical accounting policies, the use of other judgments,
estimates and assumptions could result in material differences in our results
of operations or financial condition.
Certain reclassifications have been made to the 2001 financial statements
and/or schedules to conform to the 2002 presentation. These reclassifications
may have affected certain ratios for the prior periods. The effect of such
reclassifications is considered immaterial. All significant intercompany
transactions and balances have been eliminated.
The information included in this Form 10-Q should be read in conjunction with
Banner Corporation's 2001 Annual Report on Form 10-K filed with the SEC.
Interim results are not necessarily indicative of results for a full year.
Note 2: Recent Developments and Significant Events
Mergers and Acquisitions: On January 1, 2002, the Company completed the
acquisition of Oregon Business Bank (OBB), which was headquartered in Lake
Oswego, Oregon. BB paid $10.1 million in cash for all the outstanding common
shares of OBB. OBB was merged with and into BB and operates as a division of
BB. The acquisition was accounted for as a purchase and resulted in the
recording of approximately $4.8 million of costs in excess of the fair value
of OBB's net assets acquired (goodwill). In addition, an estimated $714,000
of core deposit intangibles were recorded and will be amortized on an
accelerated basis over a five-year period resulting in a first-year charge to
earnings of $286,000. Opened in 1999, OBB was an Oregon state-chartered
community bank which had, before recording of purchase accounting adjustments,
approximately $38.9 million in total assets, $33.1 million in loans, $33.2
million in deposits and $4.7 million in shareholders' equity at December 31,
2001. OBB operates one full service branch in Lake Oswego, Oregon.
Sale of $25 Million of Trust Preferred Securities: On April 10, 2002, the
Company completed the issuance of $25 million of trust preferred securities
(TPS) in a private placement. The TPS were issued by a special purpose
business trust owned by the Company and sold to a pooled investment vehicle
sponsored by Sandler O'Neill & Partners and Salomon Smith Barney. The TPS
have been recorded as a liability on the statement of financial condition but
qualify as Tier 1 capital for regulatory capital purposes. The proceeds from
this offering are expected to be used primarily to fund growth, including
acquisitions, or may also be used to fund the Company's stock repurchase
program and other general corporate purposes as necessary.
Under the terms of the transaction, the TPS have a maturity of 30 years and
are redeemable after five years with certain exceptions. The holders of the
TPS will be entitled to receive cumulative cash distributions at a variable
annual rate, with a current interest rate of 6.0154%, reset semi-annually
equal to six month LIBOR plus 3.70%.
10
Accounting Standards Recently Adopted: In January 2002, the Company adopted
Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other
Intangible Assets, which applies to all acquired intangible assets whether
acquired singly, as part of a group, or in a business combination. This
statement requires that goodwill not be amortized; however, goodwill for each
reporting unit must be evaluated for impairment on at least an annual basis
using a two-step approach. The first step used to identify potential
impairment compares the estimated fair value of a reporting unit to its
carrying amount, including goodwill. If the fair value of a reporting unit is
less than its carrying amount, the second step of the impairment evaluation,
which compares the implied fair value of goodwill to its carrying amount, must
be performed to determine the amount of the impairment loss, if any. This
statement also provides standards for financial statement disclosures of
goodwill and other intangible assets and related impairment losses. The
adoption of this statement has had a material impact on the Company's results
of operation. Goodwill is no longer being amortized, reducing other current
period operating expenses by an estimated $795,000 per quarter, or $3.2
million a year, with a corresponding increase in net income. The Company has
performed its initial assessment of goodwill impairment during the second
quarter of 2002 and has determined that its goodwill is not impaired.
In August 2001, SFAS No. 144, Accounting for the Impairment or Disposal of
Long-Lived Assets, was issued. The statement supercedes SFAS No. 121,
Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets
to Be Disposed Of, but retains the requirements relating to recognition and
measurement of an impairment loss and resolves certain implementation issues
resulting from SFAS No. 121. The statement was adopted by the Company on
January 1, 2002 and did not have a material impact on the results of
operations or financial condition of the Bank.
Note 3: Adoption of SFAS No. 141 and 142 Goodwill, Intangible Assets and
Acquisitions
The following table shows the pro forma effects of SFAS No. 142 applied to the
prior comparative period (in thousands except per share amounts):
Quarters Ended Six Months Ended
June 30 June 30
------------------- ---------------------
2002 2001 2002 2001
-------- -------- -------- --------
Reported Net Income $ 3,527 $ 1,619 $ 7,436 $ 3,928
Add back: Goodwill
amortization -- 795 -- 1,590
-------- -------- -------- --------
Adjusted Net Income $ 3,527 $ 2,414 $ 7,436 $ 5,518
======== ======== ======== ========
Basic earnings per share as
reported: $ 0.32 $ 0.14 $ 0.67 $ 0.35
Goodwill amortization -- .08 -- 0.14
-------- -------- -------- --------
Adjusted basic earnings per
share $ 0.32 $ 0.22 $ 0.67 $ 0.49
======== ======== ======== ========
Diluted earnings per share as
reported: $ 0.30 $ 0.14 $ 0.65 $ 0.34
Goodwill amortization -- .07 -- 0.13
-------- -------- -------- --------
Adjusted diluted earnings
per share $ 0.30 $ 0.21 $ 0.65 $ 0.47
======== ======== ======== ========
Acquisition of OBB: The following table summarizes the estimated fair values
of the assets acquired and liabilities assumed at the date of acquisition.
January 1, 2002
---------
(in thousands)
Cash $ 3,572
Securities 1,531
Loans receivable 33,648
Property and equipment 237
Other assets 49
Core deposit intangible (CDI) 714
Goodwill 4,793
---------
Total Assets Acquired 44,544
---------
Deposits (33,499)
Borrowings (701)
Other liabilities (253)
---------
Total Liabilities Assumed (34,453)
---------
Net Assets Acquired $ 10,091
=========
The $714,000 of acquired intangible assets was assigned to core deposit
intangible and is being amortized on an accelerated basis over a five-year
useful life. Loans receivable and deposits were assigned fair market
valuation premiums of $534,000 (three-year average life) and $347,000 (two-
year average life), respectively. The premiums are being amortized using a
level yield method. The $4.8 million of goodwill was assigned to OBB's
ongoing business relationships. None of the goodwill is expected to be
deductible for income tax purposes.
11
Intangible Assets: The gross carrying amount and accumulated amortization of
the Company's intangible assets other than goodwill as of June 30, 2002 is as
follows (in thousands):
June 30, 2002
----------------------------------
Gross Net
Carrying Accumulated Carrying
Amount Amortization Amount
------- ------------ -------
Core Deposit Intangible (CDI) $ 714 $ (127) $ 587
Mortgage Servicing Rights (MSR)* $ 1,530 $ (70) $ 1,460
------- ------- -------
$ 2,244 $ (197) $ 2,047
======= ======= =======
* Amortization of mortgage servicing rights is recorded as a reduction of loan
servicing income. Mortgage servicing rights are recorded on an individual
loan basis with the gross carrying amount and accumulated amortization fully
written off if the loan repays in full.
Amortization expense for the quarter and six months ended June 30, 2002
includes $53,000 and $127,000, respectively, of expense related to the CDI
amortization and $191,000 and $288,000 for the quarter and six months,
respectively, of expense related to the MSR amortization.
Estimated amortization expense in future years with respect to existing
intangibles (in thousands):
Year Ended CDI MSR TOTAL
----------------- ------ ------ -----
December 31, 2002 $ 255 $ 267 $ 522
December 31, 2003 200 219 419
December 31, 2004 143 183 326
December 31, 2005 86 152 238
December 31, 2006 30 127 157
Note 4: Business Segments
BB is a community oriented commercial bank chartered in the State of
Washington. BB's primary business is that of a traditional banking
institution, gathering deposits and originating loans for portfolio in its
primary market area. BB offers a wide variety of deposit products to its
consumers and commercial customers. Lending activities include the
origination of real estate, commercial/agriculture business and consumer
loans. BB is also an active participant in the secondary market, originating
residential loans for sale on both a servicing released and servicing retained
basis. In addition to interest income on loans and investment securities, BB
receives other income from deposit servicing charges, loan servicing fees and
from the sale of loans and investments. BB also has a mortgage lending
subsidiary, Community Financial Corporation (CFC), located in the Lake Oswego
area of Portland, Oregon, that was established in fiscal 2000. CFC's primary
lending activities are in the area of construction and permanent financing for
one- to four-family residential dwellings.
Generally accepted accounting principles establish standards to report
information about operating segments in annual financial statements and
require reporting of selected information about operating segments in interim
reports to stockholders. They also establish standards for related
disclosures about products and services, geographic areas and major customers.
The Company has determined that its current business and operations consist of
a single business segment.
Note 5: Additional Information Regarding Interest-Bearing Deposits and
Securities
Encumbered Securities: Securities labeled "Encumbered" are pledged securities
that are subject to certain agreements which may allow the secured party to
either sell and replace them with similar but not the exact same security or
otherwise pledge the securities. In accordance with SFAS No. 140, the amounts
have been separately identified in the Consolidated Statements of Financial
Condition as "Encumbered."
The following table sets forth additional detail on BANR's interest-bearing
deposits and securities at the dates indicated (at carrying value) (in
thousands):
June 30 December 31 June 30
2002 2001 2001
--------- --------- ---------
Interest-bearing deposits included
in cash and due from banks $ 24,378 $ 12,408 $ 9,001
Mortgage-backed securities 206,726 207,185 183,617
Other securities-taxable 144,323 82,259 83,754
Other securities-tax exempt 22,136 23,673 27,465
Other stocks with dividends 2,854 3,558 3,954
--------- --------- ---------
Total securities 376,039 316,675 298,790
Federal Home Loan Bank (FHLB) stock 31,800 30,840 29,780
--------- --------- ---------
$ 432,217 $ 359,923 $ 337,571
========= ========= =========
12
The following table provides additional detail on income from deposits and
securities for the periods indicated (in thousands):
Quarters Ended Six Months Ended
June 30 June 30
------------------ ------------------
2002 2001 2002 2001
------- ------- ------- -------
Mortgage-backed securities-
interest $ 2,886 $ 3,005 $ 5,442 $ 6,277
Taxable interest and dividends 1,888 1,554 3,310 3,320
Tax-exempt interest 330 412 662 828
Federal Home Loan Bank stock-
dividends 470 511 927 973
------- ------- ------- -------
2,688 2,477 4,899 5,121
------- ------- ------- -------
$ 5,574 $ 5,482 $10,341 $11,398
======= ======= ======= =======
Note 6: Calculation of Weighted Average Shares Outstanding for Earnings Per
Share (EPS)
The following table reconciles total shares originally issued to weighted
shares outstanding used to calculate earnings per share data (in thousands):
Quarters Ended Six Months Ended
June 30 June 30
----------------- ------------------
2002 2001 2002 2001
------ ------ ------ ------
Total shares originally issued 13,201 13,201 13,201 13,201
Less retired shares and
treasury stock plus unvested
shares allocated to MRP (1,554) (1,391) (1,572) (1,348)
Less unallocated shares held by
the ESOP (577) (633) (577) (633)
------ ------ ------ ------
Basic weighted average shares
outstanding 11,070 11,177 11,052 11,220
Plus unvested MRP and stock
option incremental shares
considered outstanding for
diluted EPS calculations 512 506 463 433
------ ------ ------ ------
Diluted weighted average shares
outstanding 11,582 11,683 11,515 11,653
====== ====== ====== ======
Note 7: Restatement of Financial Statements
Restatement of Financial Statements: On September 17, 2001, the Company
announced that it had become aware of irregularities associated with a former
senior lending officer. The irregularities included a check kiting scheme of
a single commercial loan customer, as well as activities designed to conceal
credit weaknesses of several loan customers. Upon further review, the Company
determined that it would be necessary to file amended quarterly reports on
Form 10-Q/A for each of the quarters ended March 31, 2001 and June 30, 2001,
to recognize charges in those periods which appropriately reflect the timing
of losses incurred as a result of the check kiting and credit manipulation
activities. For the restated quarter ended March 31, 2001, the Company
recorded an expense of $3.6 million ($2.3 million after tax) as a result of
the check kiting scheme. During the restated quarter ended June 30, 2001, the
Company recorded $2.6 million ($1.7 after tax) of expense related to the check
kiting scheme and an additional $2.0 million ($1.3 million after tax) was
added to the provision for loan losses. The Company recorded an additional
expense of $1.9 million in the quarter ended September 30, 2001, with respect
to the check kiting scheme and also recognized $4.2 million and $4.0 million,
respectively, of additional provision for loan losses associated with the
credit manipulation in the quarters ended September 30, 2001 and December 31,
2001. The changes in the consolidated financial statements resulted in
restated net income of $2.3 million for the quarter ended March 31, 2001 and
$1.6 million for the quarter ended June 30, 2001, compared to $4.6 million and
$4.6 million, respectively, as previously reported. For the six months ended
June 30, 2001, restated net income was $3.9 million compared to $9.2 million
as previously reported.
13
ITEM 2 - Management's Discussion and Analysis of Financial Condition and
Results of Operations
Special Note Regarding Forward-Looking Statements
Management's Discussion and Analysis (MD&A) and other portions of this report
contain certain "forward-looking statements" concerning the future operations
of Banner Corporation. Management desires to take advantage of the "safe
harbor" provisions of the Private Securities Litigation Reform Act of 1995 and
is including this statement for the express purpose of availing the Company of
the protections of such safe harbor with respect to all "forward-looking
statements" contained in this report and our Annual Report. We have used
"forward-looking statements" to describe future plans and strategies,
including our expectations of the Company's future financial results.
Management's ability to predict results or the effect of future plans or
strategies is inherently uncertain. Factors which could affect actual results
include interest rate trends, the general economic climate in the Company's
market area and the country as a whole, the ability of the Company to control
costs and expenses, the ability of the Company to efficiently incorporate
acquisitions into its operations, the Company's ability to successfully
complete consolidation and conversion activities, successfully resolve
outstanding credit issues and/or recover check kiting losses, competitive
products and pricing, loan delinquency rates, and changes in federal and state
regulation. These factors should be considered in evaluating the
"forward-looking statements," and undue reliance should not be placed on such
statements.
General
Banner Corporation (the Company or BANR), a Washington corporation, is
primarily engaged in the business of planning, directing and coordinating the
business activities of its wholly owned subsidiary, Banner Bank (BB). BB is a
Washington-chartered commercial bank the deposits of which are insured by the
FDIC under both the BIF and the SAIF. BB conducts business from its main
office in Walla Walla, Washington, and its 41 branch offices and six loan
production offices located in 19 counties in Washington, Idaho and Oregon.
The operating results of BANR depend primarily on its net interest income,
which is the difference between interest income on interest-earning assets,
consisting of loans and investment securities, and interest expense on
interest-bearing liabilities, composed primarily of savings deposits and
Federal Home Loan Bank (FHLB) advances. Net interest income is primarily a
function of BANR's interest rate spread, which is the difference between the
yield earned on interest-earning assets and the rate paid on interest-bearing
liabilities, as well as a function of the average balance of interest-earning
assets as compared to the average balance of interest-bearing liabilities. As
more fully explained below, BANR's net interest income increased for the
quarter ended June 30, 2002 compared to the same period a year earlier,
reflecting a 39 basis point increase in the interest rate spread and growth in
interest bearing assets and liabilities. The net interest margin also
increased, expanding 26 and 19 basis points for the quarter and six months
ended June 30, 2002, respectively, when compared to the same period one year
prior. BANR's net income also is affected by provisions for loan losses and
the level of its other income, including deposit service charges, loan
origination and servicing fees, and gains and losses on the sale of loans and
securities, as well as its non-interest operating expenses and income tax
provisions. The provision for loan losses increased significantly for the
quarter and six months ended June 30, 2002, compared to the same periods ended
June 30, 2001. As explained more fully below and in Note 7 of the Selected
Notes to the Consolidated Financial Statements, much of this increase reflects
impaired loans associated with a former senior commercial loan officer that
had been manipulated to conceal credit weaknesses. Continued weak economic
conditions, particularly in some of the Puget Sound market areas serviced by
the Company were also a factor with respect to the higher level of provision
for loan losses. Other operating income remained relatively flat for both the
quarter and six months ended June 30, 2002. Other operating expenses
decreased for the quarter and six months ended June 30, 2002, compared to the
same periods ended June 30, 2001. As explained below and in Note 7 of the
Selected Notes to the Consolidated Financial Statements, non-interest expenses
for the quarter and six months ended June 30, 2001, included check kiting
losses of $2.6 million and $6.2 million, respectively, which were not a factor
in 2002. In addition the Company's amortization expense for goodwill and
other intangibles decreased $795,000, for the current quarter, with the
adoption of SFAS No. 142 which no longer requires amortization of goodwill.
Excluding the check kiting losses and adoption of SFAS No. 142, other
operating expenses increased compared to the year earlier amounts reflecting
the continued growth of the Company.
The MD&A is intended to assist in understanding the financial condition and
results of operations of the Company. The information contained in this
section should be read in conjunction with the Consolidated Financial
Statements and accompanying Selected Notes to the Consolidated Financial
Statements.
14
Recent Developments and Significant Events
See Notes 2 and 7 of the Selected Notes to the Consolidated Financial
Statements
Comparison of Financial Condition at June 30, 2002 and December 31, 2001
Total assets increased $77.6 million, or 3.7%, from $2.087 billion at December
31, 2001, to $2.165 billion at June 30, 2002. The growth of $77.6 million
largely reflects the acquisition of OBB on January 1, 2002, and strong deposit
growth. Securities investments increased $59.4 million from $316.7 million to
$376.0 million. The OBB acquisition provided $1.5 million of this increase.
The increase in securities resulted primarily from the purchase of taxable
notes and bonds issued by various federally sponsored agencies many containing
provisions for the issuer to call the securities. Net loans receivable (gross
loans less loans in process, deferred fees and discounts, and allowance for
loan losses) decreased $23.4 million, or 1.5%, from $1.575 billion at December
31, 2001, to $1.552 billion at June 30, 2002. This loan decrease occurred due
to a decrease of $32.8 million in loans held for sale to $10.5 million at June
30, 2002, reflecting the sale of residential mortgage loan inventory that had
built up at December 31, 2001. These balances also reflect the acquisition of
OBB on January 1, 2002, which provided $33.6 million of gross loans consisting
of $14.3 million of commercial and multi-family mortgages, $9.0 million of
construction and land loans, $839,000 of residential mortgages and $9.5
million of commercial and consumer loans. Changes in the loan portfolio mix
reflect the Company's continuing effort to increase the portion of its assets
invested in loans and more specifically the portion of loans invested in
commercial real estate, construction and land development, and non-mortgage
loans. While these loans are of inherently higher risk than residential
mortgages, management believes they can produce higher credit-adjusted returns
to the Company and provide better opportunities to develop comprehensive
banking relationships with the borrowers than most residential mortgages. The
majority of the increase in securities was funded by a net increase of $131.1
million in deposits offset by a $53.8 million decrease in borrowings. Net
income from operations also helped to fund asset growth. Deposits grew $131.1
million, or 10.1%, from $1.296 billion at December 31, 2001, to $1.427 billion
at June 30, 2002. Non-interest bearing deposits grew 8.5% to $196.2 million
from $180.8 million ate December 31, 2001. FHLB advances decreased $70.8
million from $502.0 million at December 31, 2001, to $431.2 million at June
30, 2002. Additional funding came from the issuance of $25.0 million of TPS
in April of this year. Other borrowings, primarily the reverse repurchase
agreements with securities dealers, decreased $8.0 million, from $76.7 million
at December 31, 2001, to $68.0 million at June 30, 2002.
Comparison of Results of Operations for the Quarters and Six Months Ended June
30, 2002 and 2001 (restated),
General. For the quarter ended June 30, 2002, the Company had net income of
$3.5 million, or $.30 per share (diluted), compared to net income of $1.6
million, or $.14 per share (diluted), for the quarter ended June 30, 2001, an
increase of $1.9 million. Net income for the first six months of the current
year was $7.4 million, an increase of $3.5 million from $3.9 million for the
six months ended June 30, 2001. The prior period contained expenses
associated with the check kiting scheme and additional loan loss provision
described in Note 7 of the Selected Notes to the Consolidated Financial
Statements. BANR's operating results (excluding the check kiting charges)
reflect significant growth of assets and liabilities and an improved net
interest margin which were offset by a higher level of loan loss provision and
other operating expenses. As explained below, provision for loan losses
increased not only as a result of the credit manipulation activities but also
as a result of an increased level of non-performing loans and net charge-offs.
Compared to levels a year ago, total assets increased 6.3%, to $2.165 billion,
at June 30, 2002, net loans declined slightly by 0.8%, to $1.552 billion,
deposits grew 13.2%, to $1.427 billion, and borrowings decreased 7.8%, to
$524.9 million. Average equity was 9.23% of average assets for the quarter
ended June 30, 2002, compared to 9.83% of average assets for the quarter ended
June 30, 2001. Net interest margin increased 26 basis points for the quarter
reflecting a 39 basis point increase in net interest rate spread, which was
partially offset by the increased use of interest-bearing liabilities relative
to interest-earning assets and lower yields on assets funded by
non-interest-bearing liabilities and stockholders equity. The changes in net
interest spread and net interest margin are notable in light of the
significant volatility and changes in the level of market interest rates over
the past two years. Changes in the level of interest rates during this period
initially reduced the Company's net interest margin, however, largely as a
result of declining funding costs, net interest margin has increased over the
past twelve months.
15
Interest Income. Interest income for the quarter ended June 30, 2002, was
$36.3 million compared to $39.7 million for the quarter ended June 30, 2001, a
decrease of $3.5 million, or 8.7%. The decrease in interest income occurred
despite a $104.2 million, or 5.5%, growth in average balances of interest-
earning assets as a result of a 113 basis point decrease in the average yield
on those assets. The yield on average interest-earning assets decreased to
7.28% for the quarter ended June 30, 2002, compared to 8.41% for the same
period a year earlier. Average loans receivable for the quarter ended June 30,
2002, increased by $34.6 million ($33.1 million from the acquisition of OBB),
or 2.2%, when compared to the quarter ended June 30, 2001, reflecting modest
internal growth as well as the acquisition of OBB. Interest income on loans
decreased by $3.6 million, or 10.4%, compared to $34.3 million for the prior
year, as the impact of the increase in average loan balances was offset by a
109 basis point decrease in the average yield. The decrease in average loan
yield reflects the significant decline in the level of market interest rates,
particularly the prime rate, compared to prior year levels, which offset
continued changes in the mix of the loan portfolio. The loan mix continued to
change as the portion of the portfolio invested in lower yielding one- to
four-family residential loans declined, while the portion invested in higher
yielding construction, land development and commercial loans increased. Loans
yielded 7.76% for the quarter ended June 30, 2002, compared to 8.85% for the
quarter ended June 30, 2001. While the level of market interest rates was
significantly lower than a year earlier, loan yields were supported to a
degree by certain loans with rate floors and by changes in the portfolio mix.
The average balance of mortgage-backed securities, investment securities,
daily interest-bearing deposits and FHLB stock increased by $69.6 million for
the quarter ended June 30, 2002, and the interest and dividend income from
those investments increased $92,000, compared to the quarter ended June 30,
2001. The average yield on mortgage-backed securities decreased from 6.23%
for the quarter ended June 30, 2001, to 5.54% for the comparable period in
2002. Yields on mortgage-backed securities were lower in the 2002 period
reflecting the effect of lower market rates on the interest rates paid on the
significant portion of those securities that have adjustable rates and
prepayments on certain higher-yielding portions of the portfolio. The average
yield on investment securities and short-term cash investments decreased from
6.54% for the quarter ended June 30, 2001, to 5.15% for the comparable quarter
in 2002, also reflecting the lower level of market rates. Earnings on FHLB
stock decreased by $41,000 to $470,000 in the quarter ended June 30, 2002 from
$511,000 in the comparable quarter in 2001. This resulted from a 99 basis
point decrease in the yield received on FHLB stock offset by an increase of
$2.1 million in the average balance of FHLB stock for the quarter ended June
30, 2002. The dividend yield on FHLB stock was 6.01% for the quarter ended
June 30, 2002, compared to 7.00% for the quarter ended June 30, 2001.
Dividends on FHLB stock are established on a quarterly basis by vote of the
Directors of the FHLB.
Interest income for the six months ended June 30, 2002 decreased by $8.0
million, or 10.0%, to $72.3 million from $80.3 million for the comparable
period in 2001. Interest income from loans decreased $7.0 million, or 10.1%,
from the comparable period in 2001. The decrease in loan interest income
reflects the impact of a 124 basis point decrease in the yield on the loan
balances and occurred despite a $62.9 million growth in average loans
receivable balances. Interest income from mortgage-backed and investment
securities and FHLB stock for the six months ended June 30, 2002, decreased
$1.1 million, from $11.4 million in 2001 to $10.3 million in the current
period, reflecting a $34.4 million increase in average balances offset by a
114 basis point decrease in yield.
Interest Expense. Interest expense for the quarter ended June 30, 2002, was
$16.8 million compared to $22.5 million for the comparable period in 2001, a
decrease of $5.7 million, or 25.3%. The decrease in interest expense was due
to a decrease in the average cost of all interest-bearing liabilities from
5.02% to 3.50%. The $128.2 million increase ($33.2 million from the OBB
acquisition) in average interest-bearing deposits for the quarter ended June
30, 2002, compared to June 30, 2001, reflects the solid deposit growth
throughout the Company over the past twelve months. Deposit interest expense
decreased $4.1 million for the quarter ended June 30, 2002, compared to the
same quarter a year ago. Average deposit balances increased from $1.226
billion for the quarter ended June 30, 2001, to $1.386 billion for the quarter
ended June 30, 2002, while, at the same time, the average rate paid on deposit
balances decreased 172 basis points. To a significant degree, deposit costs
for a quarter reflect market interest rates and pricing decisions made three
to twelve months prior to the end of that quarter. Generally, market interest
rates for deposits were declining and lower for the nine months preceding the
quarter ended June 30, 2002, than for the same period preceding the June 30,
2001 quarter. The reduction in deposit costs, which tends to lag declines in
market rates, continued in the most recent quarter as a result of the
cumulative effect of declining rates in the four preceding quarters as well as
sharply low rates in the current quarter. Average FHLB advances totaled
$450.0 million during the quarter ended June 30, 2002, compared to $504.6
million during the quarter ended June 30, 2001, a decrease of $54.6 million
that, combined with a 56 basis point decrease in the average cost of advances,
resulted in a $1.5 million decrease in related interest expense. The average
rate paid on those advances decreased to 5.55% for the quarter ended June 30,
2002, from 6.11% for the quarter ended June 30, 2001. FHLB advances are
generally fixed rate, fixed term borrowings. For the past two quarters, a
significant portion of maturing FHLB advances have been repaid as a result of
strong deposit growth. In the current quarter additional funding was also
provided by the issuance of $25 million of TPS. The average balance of TPS
was $22.3 million and the average rate paid was 6.09% (including amortizing
prepaid loan underwriting costs) for the quarter ended June 30, 2002. Other
borrowings consist of retail repurchase agreements with customers and reverse
repurchase agreements with investment banking firms secured by certain
investment securities. The average balance for other borrowings increased
$985,000 from $69.1 million for the quarter ended June 30, 2001, to $70.1
million for the same period in 2002, while the related interest expense
decreased $477,000 from $867,000 to $390,000 for the respective periods. The
average rate paid on other borrowings was 2.29% in the quarter ended June 30,
2002 compared to 5.03% for the same quarter in 2001. The Company's other
borrowings generally have relatively short terms and therefore reprice to
current market levels more quickly than FHLB advances which generally lag
current market rates.
A comparison of total interest expense for the six months ended June 30, 2002,
shows a decrease of $11.7 million, or 25.6% from the comparable period in June
2001. The interest expense reflects an increase in average deposits of $152.4
million combined with a $43.6 million decrease in FHLB advances and other
borrowings. The effect on interest expense of the $122.9 million increase in
average interest-bearing liabilities was offset by a 157 basis point decrease
in the interest rate paid on those liabilities.
16
The following tables provide additional comparative data on the Company's
operating performance:
Quarters Ended Six Months Ended
Average Balances June 30 June 30
---------------- --------------------- ---------------------
*Restated (See Note 7) 2002 2001* 2002 2001*
(in thousands) ---------- ---------- ---------- ----------
Investment securities and
deposits $ 172,660 $ 120,662 150,393 $ 126,187
Mortgage-backed obligations 209,030 193,511 203,695 195,573
Loans 1,586,389 1,551,811 1,596,968 1,534,087
FHLB stock 31,348 29,280 31,120 29,049
---------- ---------- ---------- ----------
Total average interest-earning
asset 1,999,427 1,895,264 1,982,176 1,884,896
Non-interest-earning assets 139,813 117,462 137,061 115,751
---------- ---------- ---------- ----------
Total average assets $2,139,240 $2,012,726 $2,119,237 $2,000,647
========== ========== ========== ==========
Deposits 1,386,332 1,226,077 1,361,457 1,209,093
Advances from FHLB 450,018 504,614 463,056 506,700
Trust preferred securities 22,253 -- 11,188 --
Other borrowings 70,068 69,083 75,036 71,894
---------- ---------- ---------- ----------
Total average interest-bearing
liabilities 1,928,671 1,799,774 1,910,737 1,787,887
Non-interest-bearing liabilities 13,191 15,179 11,716 15,190
---------- ---------- ---------- ----------
Total average liabilities 1,941,862 1,814,953 1,922,453 1,803,077
Equity 197,378 197,773 196,784 197,570
---------- ---------- ---------- ----------
Total average liabilities and
equity $2,139,240 $2,012,726 $2,119,237 $2,000,647
========== ========== ========== ==========
Interest Rate Yield/Expense (rates are annualized)
-------------------------------------------------
Interest Rate Yield:
Investment securities and
deposits 5.15% 6.54% 5.33% 6.63%
Mortgage-backed obligations 5.54% 6.23% 5.39% 6.47%
Loans 7.76% 8.85% 7.82% 9.06%
FHLB stock 6.01% 7.00% 6.00% 6.75%
---------- ---------- ---------- ----------
Total interest rate yield on
interest-earning assets 7.28% 8.41% 7.35% 8.59%
---------- ---------- ---------- ----------
Interest Rate Expense:
Deposits 2.86% 4.58% 2.97% 4.70%
Advances from FHLB 5.55% 6.11% 5.53% 6.17%
Trust preferred securities 6.09% -- 6.09% --
Other borrowings 2.29% 5.03% 2.40% 5.43%
---------- ---------- ---------- ----------
Total interest rate expense on
interest-bearing liabilities 3.50% 5.02% 3.58% 5.15%
---------- ---------- ---------- ----------
Interest spread 3.78% 3.39% 3.77% 3.44%
========== ========== ========== ==========
Net interest margin on interest-
earning assets 3.90% 3.64% 3.90% 3.71%
========== ========== ========== ==========
Additional Key Financial Ratios (ratios are annualized)
------------------------------------------------------
Return on average assets 0.66% 0.32% 0.71% 0.40%
Return on average equity 7.17% 3.28% 7.62% 4.01%
Average equity / average assets 9.23% 9.83% 9.29% 9.88%
Average interest-earning assets/
interest-bearing liabilities 103.67% 105.31% 103.74% 105.43%
Non-interest [other operating]
expenses/average assets
Excluding amortization of
costs in excess of net
assets acquired (goodwill) 2.59% 2.92% 2.58% 3.01%
Including amortization of
costs in excess of net
assets acquired (goodwill) 2.59% 3.03% 2.58% 3.12%
Efficiency ratio [non-interest
(other operating) expenses/revenues]
Excluding amortization of
costs in excess of net assets
acquired (goodwill) 60.22% 69.16% 60.22% 71.23%
Including amortization of
costs in excess of net
assets acquired (goodwill) 60.22% 72.98% 60.22% 75.09%
17
Provision and Allowance for Loan Losses. During the quarter ended June 30,
2002, the provision for loan losses was $4.0 million, compared to $3.0 million
for the quarter ended June 30, 2001, an increase of $1.0 million. A comparison
of the provision for loan losses for the six-month periods ended June 30, 2001
and 2002 shows an increase of $3.1 million from $3.9 million to $7.0 million.
The increase in the provision for loan losses reflects the amount required to
maintain the allowance for losses at an appropriate level based upon
management's evaluation of the adequacy of general and specific loss reserves
as more fully explained in the following paragraphs. The higher provisions in
the current periods reflect changes in the portfolio mix, higher levels of
non-performing loans and net charge-offs, and concerns about the current
economic environment. The provision for loan losses for the quarter and six
months ended June 30, 2002, includes $3.9 million and $5.8 million,
respectively, of loan charge-offs as a result of further deterioration in the
quality of five of the problem loans associated with the former senior lending
officer as referenced in Note 7 of the Selected Notes to the Consolidated
Financial Statements. Non-performing loans increased to $19.9 million at June
30, 2002, compared to $8.1 million at June 30, 2001. Non-performing loans are
primarily concentrated in the Seattle metropolitan area where continued
economic weakness has diminished certain borrowers' ability to meet loan
obligations, and largely, although not exclusively, reflect loans associated
with the former senior loan officer noted above. Net charge-offs were $6.3
million for the current quarter compared to $2.2 million for the same quarter
a year earlier. Net charge-offs were $8.4 million for the six months ended
June 30, 2002, compared to $2.5 million for the six months ended June 30,
2001. A comparison of the allowance for loan losses at June 30, 2002 and 2001,
shows a decrease of $129,000 from $16.8 million at June 30, 2001, to $16.6
million at June 30, 2002. The allowance for loan losses as a percentage of net
loans (loans receivable excluding allowance for losses) was 1.06% at both June
30, 2002, and at June 30, 2001. In recent months, the Company has hired
additional credit administration and special assets personnel and is directing
significant efforts at identifying problem loans and managing non-performing
assets.
In originating loans, the Company recognizes that losses will be experienced
and that the risk of loss will vary with, among other things, the type of loan
being made, the credit worthiness of the borrower over the term of the loan,
general economic conditions and, in the case of a secured loan, the quality of
the security for the loan. As a result, the Company maintains an allowance for
loan losses consistent with the generally accepted accounting principles
(GAAP) guidelines outlined in SFAS No. 5, Accounting for Contingencies. The
Company has established systematic methodologies for the determination of the
adequacy of its allowance for loan losses. The methodologies are set forth in
a formal policy and take into consideration the need for an overall general
valuation allowance as well as specific allowances that are tied to individual
problem loans. The Company increases its allowance for loan losses by charging
provisions for possible loan losses against the Company's income and values
impaired loans consistent with the guidelines in SFAS No. 114, Accounting by
Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors
for Impairment of a Loan-Income Recognition and Disclosure.
The allowance for losses on loans is maintained at a level sufficient to
provide for estimated losses based on evaluating known and inherent risks in
the loan portfolio and upon management's continuing analysis of the factors
underlying the quality of the loan portfolio. These factors include changes in
the size and composition of the loan portfolio, actual loan loss experience,
current and anticipated economic conditions, detailed analysis of individual
loans for which full collectibility may not be assured, and determination of
the existence and realizable value of the collateral and guarantees securing
the loans. Losses that are related to specific assets are usually applied as a
reduction of the carrying value of the assets and charged immediately against
the allowance for loan loss reserve. Recoveries on previously charged off
loans are credited to the allowance. The reserve is based upon factors and
trends identified by management at the time financial statements are prepared.
In addition, various regulatory agencies, as an integral part of their
examination process, periodically review the allowance for loan losses. Such
agencies may require additions to the allowance based upon judgments different
from management. Although management uses the best information available,
future adjustments to the allowance may be necessary due to economic,
operating, regulatory and other conditions beyond the Company's control. The
adequacy of general and specific reserves is based on management's continuing
evaluation of the pertinent factors underlying the quality of the loan
portfolio, including changes in the size and composition of the loan
portfolio, delinquency rates, actual loan loss experience and current economic
conditions. Large groups of smaller-balance homogeneous loans are collectively
evaluated for impairment. Loans that are collectively evaluated for impairment
include residential real estate and consumer loans. Smaller balance
non-homogeneous loans also may be evaluated collectively for impairment.
Larger balance non-homogeneous residential construction and land, commercial
real estate, commercial business loans and unsecured loans are individually
evaluated for impairment. Loans are considered impaired when, based on current
information and events, management determines that it is probable that the
Bank will be unable to collect all amounts due according to the contractual
terms of the loan agreement. Factors involved in determining impairment
include, but are not limited to, the financial condition of the borrower,
value of the underlying collateral and current status of the economy. Impaired
loans are measured based on the present value of expected future cash flows
discounted at the loan's effective interest rate or, as a practical expedient,
at the loan's observable market price or the fair value of collateral if the
loan is collateral dependent. Subsequent changes in the value of impaired
loans are included within the provision for loan losses in the same manner in
which impairment initially was recognized or as a reduction in the provision
that would otherwise be reported
The Company's methodology for assessing the appropriateness of the allowance
consists of several key elements, which include specific allowances, an
allocated formula allowance, and an unallocated allowance. Losses on specific
loans are provided for when the losses are probable and estimable. General
loan loss reserves are established to provide for inherent loan portfolio
risks not specifically provided for. The level of general reserves is based on
analysis of potential exposures existing in the Bank's loan portfolio
including evaluation of historical trends, current market conditions and other
relevant factors identified by management at the time the financial statements
are prepared. The formula allowance is calculated by applying loss factors to
outstanding loans, excluding loans with specific allowances. Loss factors are
based on the Company's historical loss experience adjusted for significant
factors including the experience of other banking organizations that, in
management's judgment, affect the collectibility of the portfolio as of the
evaluation date. During the current quarter the Company reduced the loss
factors associated with one- to four-family loans while at the same time it
increased the factors associated with non-residential loans. The unallocated
allowance is based upon management's evaluation of various factors that are
not directly measured in the determination of the formula and specific
allowances. This methodology may result in losses or recoveries differing
significantly from those provided in the financial statements.
18
The following tables are provided to disclose additional detail on the
Company's loans and allowance for loan losses (in thousands):
*Restated (See Note 7) June 30 December 31 June 30
2002 2001 2001*
Loans (including loans held for sale): ---------- ---------- ----------
Secured by real estate:
One- to four-family $ 378,566 $ 422,456 $ 404,314
Commercial 367,166 363,560 396,017
Multifamily 81,942 79,035 83,853
Construction and land 340,117 335,798 327,261
Commercial business 263,796 270,022 252,308
Agricultural business 95,375 76,501 73,053
Consumer 41,705 45,605 45,084
---------- ---------- ----------
Total Loans 1,568,667 1,592,977 1,581,890
Less allowance for loan losses 16,646 17,552 16,775
---------- ---------- ----------
Total net loans at end of period $1,522,021 $1,575,425 $1,565,115
========== ========== ==========
Allowance for loan losses as a
percentage of net loans outstanding 1.06% 1.10% 1.06%
Quarters Ended Six Months Ended
June 30 June 30
----------------- -----------------
2002 2001* 2002 2001*
------- ------- ------- -------
Balance, beginning of the period $18,899 $15,980 $17,552 $15,314
Acquisitions -- 460
Provision 4,000 2,950 7,000 3,900
Recoveries of loans previously charged off:
Secured by real estate:
One- to four-family -- 1 -- 1
Commercial (9) -- -- --
Multifamily -- -- -- --
Construction and land -- -- -- --
Commercial business 13 21 13 27
Agricultural business 1 -- 2 --
Consumer 46 -- 55 5
------- ------- ------- -------
51 22 70 33
Loans charged off:
Secured by real estate:
One- to four-family (5) (65) (11) (97)
Commercial -- -- -- --
Multifamily -- -- -- --
Construction and land (487) (14) (487) (14)
Commercial business (5,703) (1,940) (7,289) (2,042)
Agricultural business -- -- (141) (100)
Consumer (109) (158) (508) (219)
------- ------- ------- -------
(6,304) (2,177) (8,436) (2,472)
------- ------- ------- -------
Net charge-offs (6,253) (2,155) (8,366) (2,439)
------- ------- ------- -------
Balance, end of period $16,646 $16,775 $16,646 $16,775
======= ======= ======= =======
Net charge offs as a percentage of average
net book value of loans outstanding for
the period 0.39% 0.14% 0.52% 0.16%
------- ------- ------- -------
19
The following is a schedule of the Company's allocation of the allowance for
loan losses:
June 30 December 31 June 30
2002 2001 2001
Specific or allocated loss allowances: ------- ------- -------
Secured by real estate:
One- to four-family $ 670 $ 2,366 $ 2,229
Commercial 1,988 3,967 4,032
Multifamily 410 593 682
Construction and land 3,651 3,431 3,663
Commercial business 7,231 4,660 3,835
Agricultural business 1,173 990 890
Consumer 637 774 948
------- ------- -------
Total allocated 15,770 16,781 16,279
Unallocated 876 771 496
------- ------- -------
Total allowance for loan losses $16,646 $17,552 $16,775
======= ======= =======
Allowance for loan losses as a percent of
net loans (loans receivable excluding
allowance for loan losses) 1.06% 1.10% 1.06%
Other Operating Income. Other operating income was $3.5 million for the
quarter ended June 30, 2002, a decrease of $86,000 from the quarter ended June
30, 2001. This included a $348,000 decrease in the gain on sale of securities
for the current quarter. Loan sales for the quarter ended June 30, 2002
totaled $68.5 million, including $16.8 million of loans sold by CFC, compared
to $87.4 million for the quarter ended June 30, 2001. Gain on sale of loans
for BANR included $156,000 of fees on $13.4 million of loans brokered by CFC,
which are not reflected in the volume of loans sold. Other fee and service
charge income for BANR increased by $80,000 to $1.5 million for the quarter
ended June 30, 2002, compared to $1.5 million for the quarter ended June 30,
2001. Miscellaneous income increased by $148,000, largely reflecting the
Company's increased investment in bank owned life insurance and the resulting
increase in cash surrender value.
Other operating income for the six months ended June 30, 2002, increased
$267,000 from the comparable period in 2001. This includes a $336,000 increase
in the gain on sale of loans, $343,000 decrease in gain on sale of securities
and a $237,000 increase in miscellaneous income. Loan sales increased from
$134.4 million for the six months ended June 30, 2001 to $160.7 million for
the six months ended June 30, 2002.
Other Operating Expenses. Other operating expenses decreased $1.4 million from
$15.2 million for the quarter ended June 30, 2001, to $13.8 million for the
quarter ended June 30, 2002. As noted above, other operating expenses for the
quarter ended June 30, 2001, included a charge of $2.6 million associated with
a check kiting scheme that had been concealed by a former senior lending
officer of BB. In addition, the amortization of goodwill and intangibles
decreased $742,000 for the quarter ended June 30, 2002 as a result of the
adoption of SFAS No. 142. Excluding the check kiting charge and change in
goodwill amortization, other operating expenses increased $2.0 million
compared to the same quarter a year earlier. Increases in other operating
expenses, excluding the check kiting charge and change in goodwill
amortization, reflect the overall growth in assets and liabilities, customer
relationships and complexity of operations as BANR continues to expand. The
higher level of operating expenses in the current quarter includes significant
increases in compensation for credit examination and special assets personnel
as well as additional executive management and production staff hired to
re-position the Company for future growth. The increase in expenses includes
operating costs associated with OBB, which was acquired on January 1, 2002.
The increase also reflects expenses associated with the expanding operations
at BB's mortgage lending subsidiary, CFC. The higher operating expenses
associated with BANR's transition to more of a commercial bank profile caused
BANR's efficiency ratio, excluding the amortization of goodwill and check
kiting loss, to increase to 60.22% for the quarter ended June 30, 2002, from
56.68% (72.98% including goodwill and the check kiting loss) for the
comparable period ended June 30, 2001. Other operating expenses as a
percentage of average assets increased to 2.59% for the quarter ended June 30,
2002, compared to 2.35% (3.03% including goodwill and the check kiting loss)
for the quarter ended June 30, 2001.
Other operating expenses for the six months ended June 30, 2002 decreased $3.7
million from $30.9 million for the first six months of 2001 to $27.2 million
in the current period. As explained earlier, the decrease is largely due to
the previously noted check kiting loss ($6.2 million) and discontinued
amortization ($1.6 million) of goodwill offset by growth in BANR's operations
for the current six-month period.
Income Taxes. Income tax expense was $1.6 million for the quarter ended June
30, 2002, compared to $1.1 million for the comparable period in 2001. The
Company's effective tax rates for the quarters ended June 30, 2002 and 2001
were 31% and 39%, respectively. The lower effective tax rate in the current
quarter is primarily a result of a decrease in the relative effect of the
non-deductible intangible amortization expense compared to the prior quarter
reflecting the discontinuance of the amortization of goodwill.
Income tax expense for the six months ended June 30, 2002 increased to $3.5
million, compared to $2.4 million in the comparable period in 2001. The
Company's effective tax rates for the six months ended June 30, 2002 and 2001
were 32% and 38%, respectively. Similar to the quarterly results, the lower
effective tax rate in the current period is primarily a result of a decrease
in the relative effect of the non-deductible intangible amortization expense
compared to the prior quarter reflecting the discontinuance of the
amortization of goodwill.
20
Asset Quality
The Bank's asset classification committee meets at least monthly to review all
classified assets, to approve action plans developed to resolve the problems
associated with the assets and to review recommendations for new
classifications, any changes in classifications and recommendations for
reserves. The committee reports to the Board of Directors quarterly as to the
current status of classified assets and action taken in the preceding quarter.
State and federal regulations require that the Bank review and classify its
problem assets on a regular basis. In addition, in connection with
examinations of insured institutions, state and federal examiners have
authority to identify problem assets and, if appropriate, require them to be
classified. There are three classifications for problem assets: substandard,
doubtful and loss. If an asset or portion thereof is classified loss, the
insured institution establishes specific allowances for loan losses for the
full amount of the portion of the asset classified loss. A portion of general
loan loss allowances established to cover possible losses related to assets
classified substandard or doubtful may be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses generally do not qualify as regulatory capital.
At June 30, 2002 and December 31, 2001, the aggregate amounts of the Bank's
classified assets were as follows (in thousands):
June 30 December 31
2002 2001
------- -----------
Loss $ -- $ --
Doubtful 232 171
Substandard assets 36,206 32,658
Special mention 34,670 34,140
The following tables are provided to disclose additional details on asset
quality (in thousands):
June 30 December 31
2002 2001
Non-performing assets at end of the period: ------- -----------
Nonaccrual Loans:
Secured by real estate:
One- to four-family $ 757 $ 1,006
Commercial 859 415
Multifamily -- --
Construction and land 7,102 6,827
Commercial business 10,140 8,884
Agricultural business 429 86
Consumer 275 291
------- -------
19,562 17,509
Loans more than 90 days delinquent, still on accrual:
Secured by real estate:
One- to four-family 21 18
Commercial -- 325
Multifamily -- --
Construction and land -- --
Commercial business -- 39
Agricultural business 290 --
Consumer 3 152
------- -------
314 534
------- -------
Total non-performing loans 19,876 18,043
Real estate owned, held for sale, net (REO), and
other repossessed assets 6,253 3,011
------- -------
Total non-performing assets at the end of the period $26,129 $21,054
======= =======
Non-performing loans as a percentage of total
net loans before allowance for loan losses at
end of the period 1.27% 1.13%
Non-performing assets as a percentage of total
assets at end of the period 1.21% 1.01%
Troubled debt restructuring [TDRs]
at end of the period $ 598 $ 302
======= =======
21
Liquidity and Capital Resources
The Company's primary sources of funds are deposits, borrowings, proceeds from
loan principal and interest payments and sales of loans, and the maturity of
and interest income on mortgage-backed and investment securities. While
maturities and scheduled repayments of loans and mortgage-backed securities
are a predictable source of funds, deposit flows and mortgage prepayments are
greatly influenced by market interest rates, economic conditions and
competition.
The primary investing activity of the Company, through its subsidiaries, is
the origination and purchase of loans. In addition the Company maintains a
securities portfolio which management may increase or decrease in response to
changes in loan and deposit activity or market condition. During the six
months ended June 30, 2002, the Company purchased loans in the amount of $3.9
million while loan originations, net of repayments, totaled $140.9 million.
During this same six month period the securities investments increased $59.4
million. This activity was funded primarily by sales of loans and deposit
growth. During the six months ended June 30, 2002, the Company sold $160.4
million of loans. Net deposit growth was $131.1 million (including $33.2
million from acquisitions) for the six months ended June 30, 2002. FHLB
advances decreased $70.8 million for the six months ended June 30, 2002. Other
borrowings and TPS increased $17.0 million for the six months ended June 30,
2002.
The Bank must maintain an adequate level of liquidity to ensure the
availability of sufficient funds to accommodate deposit withdrawals, to
support loan growth, to satisfy financial commitments and to take advantage of
investment opportunities. During the six months ended June 30, 2002, the Bank
used its source of funds primarily to fund loan commitments, to purchase
securities, to repay FHLB advances and other borrowings, and to pay maturing
savings certificates and deposit withdrawals. At June 30, 2002, BB had
outstanding loan commitments totaling $367.2 million including undisbursed
loans in process totaling $308.4 million. BB generally maintains sufficient
cash and readily marketable securities to meet short-term liquidity needs. BB
maintains a credit facility with the FHLB-Seattle, which provides for advances
which, in aggregate, may equal the lesser of 40% of BB's assets or
unencumbered qualifying collateral, up to a total possible credit line of $865
million. Advances under this credit facility totaled $431.2 million, or 20% of
BB's assets at June 30, 2002.
At June 30, 2002, savings certificates amounted to $915.0 million, or 64%, of
the Bank's total deposits, including $707.2 million which were scheduled to
mature within one year. Historically, the Bank has been able to retain a
significant amount of its deposits as they mature. Management believes it has
adequate resources to fund all loan commitments from savings deposits,
FHLB-Seattle advances, other borrowings and sale of mortgage loans and that it
can adjust the offering rates for savings certificates to retain deposits in
changing interest rate environments.
Capital Requirements
Federally-insured state-chartered banks are required to maintain minimum
levels of regulatory capital. Under current FDIC regulations, insured
state-chartered banks generally must maintain (i) a ratio of Tier 1 leverage
capital to total assets of at least 3.0% (4.0% to 5.0% for all but the most
highly rated banks), (ii) a ratio of Tier 1 capital to risk-weighted assets of
at least 4.0% and (iii) a ratio of total capital to risk-weighted assets of at
least 8.0%. At June 30, 2002, BANR's banking subsidiary exceeded all current
regulatory capital requirements to be classified as a well capitalized
institution, the highest regulatory standard. In order to be categorized as a
well capitalized institution, the FDIC requires banks it regulates to maintain
a leverage ratio, defined as Tier 1 capital divided by total regulatory
assets, of at least 5.00%; Tier 1 (or core) capital of at least 6.00% of
risk-weighted assets; and total capital of at least 10.00% of risk-weighted
assets.
BANR, as a bank holding company, is regulated by the Federal Reserve Board
(FRB). The FRB has established capital requirements for bank holding companies
that generally parallel the capital requirements of the FDIC for banks with
$150 million or more in total consolidated assets. BANR's total regulatory
capital must equal 8% of risk-weighted assets and one half of the 8% (4%) must
consist of Tier 1 (core) capital.
The actual regulatory capital ratios calculated for BANR along with the
minimum capital amounts and ratios for capital adequacy purposes were as
follows (dollars in thousands):
Minimum for capital
Actual adequacy purposes
----------------- -----------------
Amount Ratio Amount Ratio
June 30, 2002: ------ ----- ------ ------
BANR-consolidated
Total capital to risk-
weighted assets $ 199,940 12.84% $ 124,601 8.00%
Tier 1 capital to risk-
weighted assets 182,486 11.72 62,301 4.00
Tier 1 leverage capital
average assets 182,486 8.69 83,990 4.00
22
Item 3 - Quantitative and Qualitative Disclosures About Market Risk
Market Risk and Asset/Liability Management
The financial condition and operation of the Company are influenced
significantly by general economic conditions, including the absolute level of
interest rates as well as changes in interest rates and the slope of the yield
curve. The Company's profitability is dependent to a large extent on its net
interest income, which is the difference between the interest received from
its interest-earning assets and the interest expense incurred on its
interest-bearing liabilities.
The activities of the Company, like all financial institutions, inherently
involve the assumption of interest rate risk. Interest rate risk is the risk
that changes in market interest rates will have an adverse impact on the
institution's earnings and underlying economic value. Interest rate risk is
determined by the maturity and repricing characteristics of an institution's
assets, liabilities, and off-balance-sheet contracts. Interest rate risk is
measured by the variability of financial performance and economic value
resulting from changes in interest rates. Interest rate risk is the primary
market risk affecting the Company's financial performance.
The greatest source of interest rate risk to the Company results from the
mismatch of maturities or repricing intervals for rate sensitive assets,
liabilities and off-balance-sheet contracts. This mismatch or gap is generally
characterized by a substantially shorter maturity structure for
interest-bearing liabilities than interest-earning assets. Additional interest
rate risk results from mismatched repricing indices and formulae (basis risk
and yield curve risk), and product caps and floors and early repayment or
withdrawal provisions (option risk), which may be contractual or market
driven, that are generally more favorable to customers than to the Company.
The principal objectives of asset/liability management are to evaluate the
interest-rate risk exposure of the Company; to determine the level of risk
appropriate given the Company's operating environment, business plan
strategies, performance objectives, capital and liquidity constraints, and
asset and liability allocation alternatives; and to manage the Company's
interest rate risk consistent with regulatory guidelines and approved policies
of the Board of Directors. Through such management, the Company seeks to
reduce the vulnerability of its earnings and capital position to changes in
the level of interest rates. The Company's actions in this regard are taken
under the guidance of the Asset/Liability Management Committee, which is
comprised of members of the Company's senior management. The committee closely
monitors the Company's interest sensitivity exposure, asset and liability
allocation decisions, liquidity and capital positions, and local and national
economic conditions and attempts to structure the loan and investment
portfolios and funding sources of the Company to maximize earnings within
acceptable risk tolerances.
The Company's primary monitoring tool for assessing interest rate risk is
asset/liability simulation modeling which is designed to capture the dynamics
of balance sheet, interest rate and spread movements and to quantify
variations in net interest income resulting from those movements under
different rate environments. The sensitivity of net interest income to changes
in the modeled interest rate environments provides a measurement of interest
rate risk. The Company also utilizes market value analysis, which addresses
changes in estimated net market value of equity arising from changes in the
level of interest rates. The net market value of equity is estimated by
separately valuing the Company's assets and liabilities under varying interest
rate environments. The extent to which assets gain or lose value in relation
to the gains or losses of liability values under the various interest rate
assumptions determines the sensitivity of net equity value to changes in
interest rates and provides an additional measure of interest rate risk.
The interest rate sensitivity analysis performed by the Company incorporates
beginning of the period rate, balance and maturity data, using various levels
of aggregation of that data, as well as certain assumptions concerning the
maturity, repricing, amortization and prepayment characteristics of loans and
other interest-earning assets and the repricing and withdrawal of deposits and
other interest-bearing liabilities into an asset/liability computer simulation
model. The Company updates and prepares simulation modeling at least quarterly
for review by senior management and the directors. The Company believes the
data and assumptions are realistic representations of its portfolio and
possible outcomes under the various interest rate scenarios. Nonetheless, the
interest rate sensitivity of the Company's net interest income and net market
value of equity could vary substantially if different assumptions were used or
if actual experience differs from the assumptions used.
23
Sensitivity Analysis
The table of Interest Rate Risk Indicators sets forth, as of June 30, 2002,
the estimated changes in the Company's net interest income over a one-year
time horizon and the estimated changes in market value of equity based on the
indicated interest rate environments.
Table of Interest Rate Risk Indicators
Estimated Change in
----------------------------------------
Change (In Basis Points) Net Interest Income
in Interest Rates (1) Next 12 Months Net Market Value
----------------------- ------------------- ----------------
(dollars in thousands)
+400 $(3,216) (3.8%) $(79,016) (40.2%)
+300 (2,810) (3.4%) (49,836) (25.3%)
+200 (3,419) (4.1%) (28,623) (14.5%)
+100 (3,559) (4.2%) (11,839) (6.0%)
0 0 0 0 0
-100 1,126 1.3% 1,245 0.6%
-200 (481) (0.6%) 8,963 4.6%
-300 $ N/A N/A $ N/A N/A
- ----------
(1) Assumes an instantaneous and sustained uniform change in market interest
rates at all maturities.
Another although less reliable monitoring tool for assessing interest rate
risk is "gap analysis." The matching of the repricing characteristics of
assets and liabilities may be analyzed by examining the extent to which such
assets and liabilities are "interest sensitive" and by monitoring an
institution's interest sensitivity "gap." An asset or liability is said to be
interest sensitive within a specific time period if it will mature or reprice
within that time period. The interest rate sensitivity gap is defined as the
difference between the amount of interest-earning assets anticipated, based
upon certain assumptions, to mature or reprice within a specific time period
and the amount of interest-bearing liabilities anticipated to mature or
reprice, based upon certain assumptions, within that same time period. A gap
is considered positive when the amount of interest sensitive assets exceeds
the amount of interest sensitive liabilities. A gap is considered negative
when the amount of interest sensitive liabilities exceeds the amount of
interest sensitive assets. Generally, during a period of rising rates, a
negative gap would tend to adversely affect net interest income while a
positive gap would tend to result in an increase in net interest income.
During a period of falling interest rates, a negative gap would tend to result
in an increase in net interest income while a positive gap would tend to
adversely affect net interest income.
Certain shortcomings are inherent in gap analysis. For example, although
certain assets and liabilities may have similar maturities or periods of
repricing, they may react in different degrees to changes in market rates.
Also, the interest rates on certain types of assets and liabilities may
fluctuate in advance of changes in market rates, while interest rates on other
types may lag behind changes in market rates. Additionally, certain assets,
such as ARM loans, have features that restrict changes in interest rates on a
short-term basis and over the life of the asset. Further, in the event of a
change in interest rates, prepayment and early withdrawal levels would likely
deviate significantly from those assumed in calculating the table. Finally,
the ability of some borrowers to service their debt may decrease in the event
of a severe interest rate increase.
The table of Interest Sensitivity Gap presents the Company's interest
sensitivity gap between interest-earning assets and interest-bearing
liabilities at June 30, 2002. The table sets forth the amounts of
interest-earning assets and interest-bearing liabilities which are anticipated
by the Company, based upon certain assumptions, to reprice or mature in each
of the future periods shown. At June 30, 2002, total interest-earning assets
maturing or repricing within one year exceeded total interest-bearing
liabilities maturing or repricing in the same time period by $111.3 million,
representing a one-year gap to total assets ratio of 5.14%.
24
Table of Interest Sensitivity Gap
As of June 30, 2002
Within 6 Months 1-3 3-5 5-10 Over 10
6 Months to One Year Years Years Years Years Total
-------- -------- -------- -------- -------- -------- ----------
(dollars in thousands)
<c> <c> <c> <c> <c> <c> <c> <c>
Interest-earning assets(1):
Construction loans $233,366 $ 1,423 $ 2,190 $ 797 $ -- $ -- $ 237,776
Fixed-rate mortgage loans 84,592 57,498 140,291 109,561 37,460 49,785 579,187
Adjustable-rate mortgage loans 209,880 60,919 65,639 15,936 3,743 -- 356,117
Fixed-rate mortgage-backed
securities 18,658 5,045 20,074 15,378 32,090 63,857 155,102
Adjustable-rate mortgage-backed
securities 53,273 -- -- -- -- -- 53,273
Fixed-rate commercial /agriculture
loans 26,501 26,488 31,479 13,261 6,553 225 104,507
Adjustable-rate commercial/
agriculture loans 226,984 5,574 1,203 1,659 311 -- 235,731
Consumer and other loans 28,657 6,735 14,509 6,997 1,832 342 59,072
Investment securities and
interest-bearing deposits 98,478 47,600 10,935 3,330 13,538 49,091 222,972
-------- -------- -------- -------- -------- -------- ----------
Total rate-sensitive assets 980,389 211,282 286,320 166,919 195,527 163,300 2,003,737
-------- -------- -------- -------- -------- -------- ----------
Interest-bearing liabilities(2):
Regular savings and NOW accounts 21,377 21,377 49,879 49,879 -- -- 142,512
Money market deposit accounts 86,819 52,091 34,727 -- -- -- 173,637
Certificates of deposit 548,444 156,588 156,244 49,436 4,167 90 914,969
FHLB advances 82,370 44,790 106,494 75,600 121,079 849 431,182
Other borrowings 54,692 -- -- -- -- -- 54,692
Retail repurchase agreements 11,037 743 1,477 -- -- -- 13,257
-------- -------- -------- -------- -------- -------- ----------
Total rate-sensitive liabilities 804,739 275,589 348,821 174,915 125,246 939 1,730,249
-------- -------- -------- -------- -------- -------- ----------
Excess (deficiency) of interest-
sensitive assets over interest-
sensitive liabilities $175,650 $(64,307) $(62,501) $ (7,996) $ 70,281 $162,361 $ 273,488
======== ======== ======== ======== ======== ======== ==========
Cumulative excess (deficiency) of
interest-sensitive assets $175,650 $111,343 $ 48,842 $ 40,846 $111,127 $273,488 $ 273,488
======== ======== ======== ======== ======== ======== ==========
Cumulative ratio of interest-
earning assets to interest-
bearing liabilities 121.83% 110.31% 103.42% 102.55% 106.43% 115.81% 115.81%
======== ======== ======== ======== ======== ======== ==========
Interest sensitivity gap to
total assets 8.11% (2.97%) (2.89%) (0.37%) 3.25% 7.50% 12.63%
======== ======== ======== ======== ======== ======== ==========
Ratio of cumulative gap to total
assets 8.11% 5.14% 2.26% 1.89% 5.13% 12.63% 12.63%
======== ======== ======== ======== ======== ======== ==========
(footnotes on following page)
25
Footnotes for Table of Interest Sensitivity Gap
- -----------------------------------------------
(1) Adjustable-rate assets are included in the period in which interest rates
are next scheduled to adjust rather than in the period in which they are due
to mature, and fixed-rate assets are included in the periods in which they are
scheduled to be repaid based upon scheduled amortization, in each case
adjusted to take into account estimated prepayments. Mortgage loans and other
loans are not reduced for allowances for loan losses and non-performing loans.
Mortgage loans, mortgage-backed securities, other loans, and investment
securities are not adjusted for deferred fees and unamortized acquisition
premiums and discounts.
(2) Adjustable- and variable-rate liabilities are included in the period in
which interest rates are next scheduled to adjust rather than in the period
they are due to mature. Although the Bank's regular savings, NOW, and money
market deposit accounts are subject to immediate withdrawal, management
considers a substantial amount of such accounts to be core deposits having
significantly longer maturities. For the purpose of the gap analysis, these
accounts have been assigned decay rates to reflect their longer effective
maturities. If all of these accounts had been assumed to be short-term, the
one year cumulative gap of interest-sensitive assets would have been negative
$23.1 million or (1.07%) of total assets. Interest-bearing liabilities for
this table exclude certain non-interest-bearing deposits which are presented
in the average balance calculations in the table included in Item 2,
Management's Discussion and Analysis of Financial Conditions and Results of
Operations, and Comparison of Results of Operations for the Quarters and Six
Months Ended June 30, 2002 and 2001 (restated).
26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings
From time to time BANR or its subsidiaries are engaged in legal proceedings
in the ordinary course of business, none of which is considered to have a
material impact on the BANR's financial position or results of operations.
Item 2. Changes in Securities
Not Applicable
Item 3. Defaults Upon Senior Securities
Not Applicable
Item 4. Submission of Matters to a Vote of Stockholders
The annual meeting of stockholders of the Company (meeting) was held on
April19, 2002. At the meeting there were a total number of 11,598,103 shares
eligible to vote of which 10,362,022 were received or cast at the meeting.
The result of the vote on the election of directors, the first proposal
presented at the meeting, is as follows:
The following individuals were elected as directors:
FOR WITHHELD
------------------------- -------------------------
# of votes percentage of # of votes percentage of
shares voted shares voted
---------- ------------- ---------- -------------
Jesse G. Foster 10,265,310 99.07% 96,712 0.93%
Dean W. Mitchell 10,249,424 98.91% 112,598 1.09%
Brent A. Orrico 10,186,003 98.30% 176,019 1.70%
D. Michael Jones 10,269,330 99.11% 92,692 0.89%
The terms of Directors Robert D. Adams, David B. Casper, Margaret C.
Langlie, Wilbur Pribilsky, Gary Sirmon and Steve Sundquist continued.
Director S. Rick Meikle resigned effective January 3, 2002.
The result of the vote on the approval of the appointment of Deloitte &
Touche LLP as independent auditors for the fiscal year ending December 31,
2002, the second proposal at the meeting, is as follows:
# of votes percentage of shares voted
---------- --------------------------
FOR 10,284,959 99.26%
AGAINST 44,657 0.43%
ABSTAIN 32,406 0.31%
Item 5. Other Information
Not Applicable
Item 6. Exhibits and Reports on Form 8K
Report(s) on Form 8-K filed during the quarter ended June 30, 2002, are as
follows:
Date Filed Purpose
---------- -------
None
27
SIGNATURES
- ----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Banner Corporation
August 14, 2002 /s/D. Michael Jones
-------------------------------------
D. Michael Jones
President and Chief Executive Officer
(Principal Executive Officer)
August 14, 2002 /s/ Lloyd W. Baker
-------------------------------------
Lloyd W. Baker
Treasurer and Executive Vice President
(Principal Financial and Accounting Officer)
28
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER
OF BANNER CORPORATION
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
The undersigned hereby certify, pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 and in connection with this Quarterly Report on Form 10-Q, that:
- the report fully complies with the requirements of Sections 13(a) and
15(d) of the Securities Exchange Act of 1934, as amended, and
- the information contained in the report fairly presents, in all
material respects, the company's financial condition and results of
operations.
August 14, 2002 /s/D. Michael Jones
------------------------
D. Michael Jones
Chief Executive Officer
August 14, 2002 /s/Lloyd W. Baker
------------------------
Lloyd W. Baker
Chief Financial Officer
29